Published November 5th, 2016 by Bob Ciura
Pentair (PNR) is based in the U.K., but has large operations in Europe and the U.S., as well as other international regions. It has a long history; some of Pentair’s acquired businesses have been in business for over 150 years. Pentair itself was formed in 1966, under the direction of the company’s “founding five” members.
In 1968, Pentair acquired Peavey Paper Mills. It quickly grabbed a leadership position in the paper products industry. Paper fueled the company’s growth over the next decade, until management decided to diversify into other product categories.
Pentair made its first investment outside of paper products when it acquired Porter-Cable, a manufacturer of portable electronic power tools.
Through the decades, Pentair has continued to diversify its product line and build its business through acquisitions into new industries.
Pentair has a long history of growth… And of raising its dividend payments. The company has increased its dividends for 40 consecutive years. This makes Pentair one of only 50 Dividend Aristocrats – stocks with 25+ years of consecutive dividend increases. You can see the full list of Dividend Aristocrats here.
Keep reading this article to learn more about the investment prospects of Pentair.
When investors think of Pentair, they should think of one word: water. Water is the focus of Pentair’s business model.
It is a diversified manufacturer of industrial components. Pentair generates $6.4 billion of annual revenue, which is split fairly evenly among its product categories and customer base.
Source: 2016 Electrical Products Group Presentation, page 5
Pentair is also diversified geographically. Approximately 52% of its annual revenue comes from outside the U.S.
While Pentair started out in paper products, and over the years diversified into other products, it now focuses heavily on water, food, and energy. It made this decision because it saw the biggest opportunity in solving one of the world’s biggest challenges—the rising global population and the ensuing strain on global resources.
Today, approximately 75% of Pentair’s products, services, and technologies are related to food, water, or energy.
Pentair makes products that help reduce energy costs, increase efficiency, and reduce maintenance costs for customers. Pentair also develops technologies that help separate solids, liquids, and gases for treatement and reuse of water.
In addition, Pentair helps businesses manage and treat their water supply, including increasing energy reclamation from wastewater streams.
Pentair has a very attractive growth profile. Over the past 10 years, the company grew earnings by 8% compounded annually. This is a very impressive growth rate, since this period of time included the Great Recession.
Going forward, it would not be unreasonable to expect an even better performance from Pentair. The company could reach 10% annualized growth in earnings-per-share. The global economy continues to expand, and the industrial manufacturing industry is ripe for consolidation.
Indeed, Pentair relies heavily upon acquisitions for growth. For example, in the fiscal third quarter, acquisitions added 11% to Pentair’s revenue growth.
Source: Q3 Earnings Presentation, page 6
Another future catalyst for earnings-per-share growth is a lower tax rate. In 2014, Pentair reincorporated in Ireland, where the corporate tax rate is lower than in more developed regions like the U.S.
This is expected to be a meaningful boost to earnings-per-share. In 2005, Pentair paid a corporate tax rate of nearly 35%. For the full year 2016, management expects Pentair’s tax rate to be 21.5%.
Pentair expects its combination of accretive acquisitions, organic growth, and lower taxation expense, to result in double-digit adjusted earnings growth by 2020.
Source: 2016 Electrical Products Group Presentation, page 15
Competitive Advantages & Recession Performance
Pentair has raised its dividend each year for the past four decades. No company can do this without a clear, sustainable competitive advantage.
One of its biggest competitive advantages is its high margins. The company has utilized its proprietary Pentair Integrated Management System, or PIMS. PIMS enables leaner manufacturing processes and drives efficiency of supply chain and distribution.
Source: 2016 Electrical Products Group Presentation, page 13
The PIMS is an organization-wide system. It effects talent management by providing employees with the proper incentives and providing all employees with individual responsibility down to the operator level.
Within the PIMS system, the Lean Enterprise system helps to increase profit margins. It drives margin expansion by increasing productivity at manufacturing sites, and helps identify acquisition targets with the highest cost savings opportunities.
Its competitive advantages and high margins allowed the company to remain profitable during the Great Recession of during 2007-2009:
- 2007 earnings-per-share of $2.08
- 2008 earnings-per-share of $2.20
- 2009 earnings-per-share of $1.47
As a global industrial manufacturer, Pentair is not immune from recessions. However, it quickly bounced back. Pentair’s earnings-per-share reached a new high in 2011.
Pentair’s competitive advantages have helped the company navigate the difficult business climate this year. Last quarter, total revenue excluding currency fluctuations declined 2% year over year. However, margin expansion helped operating profit rise 20%. Return on sales expanded 110 basis points from the same quarter last year.
Valuation & Expected Total Return
Pentair stock trades for a price-to-earnings ratio of 14.5 (using adjusted earnings). It is modestly cheaper than the S&P 500 Index, which has a price-to-earnings ratio of 24.
That being said, Pentair’s average price-to-earnings ratio since 2000 is 15; as a result, it is difficult to argue the stock is undervalued, given its own historical valuation trends.
Therefore, investors should expect future returns to be made up of earnings-per-share growth. A reasonable base case assumption would be 10% annual earnings growth, comprised of the following factors:
- 4%-6% organic revenue growth
- 1%-2% acquisitions
- 2% share repurchases
- 2% tax impact
Even when using modest assumptions, total returns could easily reach 11%-13% per year, once you include Pentair’s 2.5% dividend yield.
Pentair has a high-quality business and several opportunities for future growth. It should realize significant revenue growth from internal investment and acquisitions. In addition, its PIMS system is creating opportunities for margin expansion.
The stock is reasonably valued based on its price-to-earnings ratio. And, the company provides shareholders with an above-average dividend yield as well as consistent dividend growth each year.
Pentair may not be the most exciting stock, but it is a reliable Dividend Aristocrat. Pentair stock is a worthwhile consideration for dividend growth investors looking for exposure to the industrial sector. The company ranks in the top 25% of stocks with 25+ years of steady or rising dividends using The 8 Rules of Dividend Investing.